Sector underperformance leaves it at extreme levels    After a year of chasing growth, we now prefer market leaders in maturemarkets. Many offer substantial real dividend and FCF yields, and these large,integrated operators are generally well positioned for cloud and IoT led growth,which we expect the market to gradually become aware of, driving multipleexpansion. We think it is hard to go past Telstra, China Mobile, HKT, SKTelecom and Singtel at this stage (and also Idea), and have skewed our modelportfolio in the direction of such firms, adding Telstra and HKT.    Good things starting to happen    Telcos have retreated 3% in the last 3M, giving up the prior quarter’s gain, andconfirming the sector’s narrow trading range. However Asia-ex Japangenerated 2% EBITDA growth, the second best in eight quarters, andcoinciding with a notable management shift YTD in ID, PH, TW and TH fromcompetition towards profitability. However, in the last three months sector EPSforecasts for 2017have generally been trimmed. We expect the profitabilityfocus to prevail. We sense a drive to lift profitability and FCF, and note thateven in HK, which has got more competitive, HKT was talking of “greenshoots”. While AU, IN, KR and SG have issues, we doubt the reality will reflectthe degree of punishment that many of their stocks have endured. We also seeefforts to lift value in general, as reflected by China Mobile’s special dividend,China Unicom’s mixed ownership, and Hutchison selling its fixed line unit.(Please see our July 12FITT, M&A Spike heralds the Value-added era, formore).    Turning 180degrees – the risk now is ignoring value, we think    High yield had its run after the GFC through to around 2015– so after that longrally, should be expected to lag until the next downturn. However, Mr. Marketalways asks difficult questions, in this case, by making high-yield higher, ormore sustainable. We see real dividend and FCF yields of impressive scale. Sowe are turning our attention away from the young stars of the telco index,back to the more mature ones, which have been ignored at the telecom boxoffice over the last two years. We believe investors will also find it hard toresist, as their FCF growth, low P/Es, and efforts to add value and earningsgrowth become clearer.    Valuation and risks    We value the telecoms on DCF, and the holdcos on SOTP. Our WACCs aretypically based on local 10-year bonds, with risk premiums of 4.5-5.5%, andterminal growth rates of 0-2%. Key downside risks include: 1) Interest ratesrebounding, cutting sector value, 2) Competition deteriorating, and 3) Risk ofspectrum pricing rising on competitive or regulatory change. Key upside risksinclude: 1) Hype on IoT, e-commerce, and data monetization driving earningsestimates and multiples, and 2) Low, and even negative, interest rates leadingto an upward squeeze in valuations.

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